Investment in Colombian sovereign debt has regained its popularity despite crises in other emerging markets

Colombian sovereign bonds have once again proven their attractiveness to international investors. The popularity of these instruments has been demonstrated by the interest shown by credit institutions, pension funds, foreign investment funds, and insurance companies, which made significant investments in the country’s treasury securities during a February 2014 issuance. This marked a rebound in demand from institutional investors, who purchased a total of COP1trn ($500m) of government debt that month, in contrast to a COP129bn ($64.5m) decline in total holdings the month before.

A Vibrant Market

Colombia’s bond market represents nearly 75% of the activity on the Colombian Stock Exchange, and of this, public debt represents nearly 90%. According to the Ministry of Finance, as of the beginning of 2014, the Colombian government had $20.9bn in active external sovereign bonds, mostly in US dollars and with a range of maturities.

After a milestone number of Colombian bond issuances in 2012 and early 2013, the US Federal Reserve’s June 2013 announcement regarding the eventual gradual tapering of asset purchases then caused increased volatility in global capital markets, including the Colombian capital markets (see Capital Markets chapter).

However, local investors have since regained their confidence and have progressively increased their sovereign debt holdings. In January 2014, local pension funds demonstrated renewed confidence in the market when they re-invested in government securities and purchased COP1.3trn ($650m) of fixed-rate securities. In total, pension funds now have COP48trn ($24bn) worth of treasury securities in their possession. Like pension funds, local banks have also invested heavily in bonds. In February 2014, banks acquired titles for a total of COP1.2trn ($600m).

Growing Foreign Interest

While the growing confidence of local sovereign bond investors is quite positive, the best auspices of the Andean country’s progress can be seen in the rising levels of investment by foreign capital funds, which recorded a 6.65% share of total holdings in February 2014 – the highest participation by foreign investors in the history of Colombian sovereign debt, according to data from Capital Credicorp.

This increase in foreign participation translated into a total of COP582bn ($291m) in net purchases for the month of February. The confidence that foreign investors have shown in Colombia's public debt is big news, particularly in the context of outflows from other emerging markets, which are experiencing significant declines in foreign investment.

Public Appreciation

In mid-March 2014 JP Morgan announced that the weight of Colombian government debt within the firm’s Government Bond Index-Emerging Markets (GBI-EM) Global Diversified and the GBI-EM Global indices would be substantially increased. By improving its position on these indices, Colombia will achieve greater diversification with regards to holders of its domestic debt securities, as well as more liquidity and therefore greater financial stability.

Colombia’s GBI-EM Global Diversified index participation is set to increase from 3.2% to 8.0% while its participation in the GBI-EM Global could rise from the current 1.8% up to 5.6% Following the announcement, Credicorp Capital – the brokerage giant that resulted from the integration of BCP Capital in Peru, Colombia’s Correval, US-based CSI and IM Trust from Chile – estimated that, based on the securities involved in the indices, those securities due in 2016, 2022 and 2024 would presumably observe the largest increase in net purchases by September 2014.

The announcement by JP Morgan helped some bond prices rise to a two-year record, with the American financial firm advising that Colombian bonds should be offered together with larger developing economies such as Turkey and Thailand. Previously, Colombia's weighting was closer in measure to smaller markets like those of Peru and Romania, according to a March 2014 report by The Wall Street allocation data provider EPFR Global reported that Colombia sold a total of $622.5m worth of debt on the local bond market in the first quarter of 2014, which was the largest inflow seen by any emerging country. EPFR compared Colombia’s success against the inflow of income from bonds in other emerging economies, including South Korea and Poland. Each of these three countries had less than $200m enter their markets in the same period. These trends would suggest that Colombia’s efforts to attract more foreign investors are paying off.

While the prospects for Colombia’s sovereign debt at the time of writing remain generally optimistic, sovereign bonds recently suffered from the start of interest rate hikes announced by the central bank on April 25, 2014. Although economists generally shared the view that the rise in interest rates was somewhat expected, they also agree that the rise of 25 basis points, to 3.5% in April, happened too early and perhaps unnecessarily altered market perceptions. Leading up to the announcement, consumer spending had been rising at the fastest pace since 2012 and employment and industrial output data published in April 2014 exceeded initial forecasts. Thus, the central bank, Banco de la Repú blica de Colombia, reported an acceleration in the annual rate of inflation and therefore decided to raise the interest rate – despite an inflation rate of 2.51% reported in March 2014, still far below the central bank’s target of 3% for 2014.

By the end of the following month, Banco de la República raised the interest rate a further 25 basis points to reach 3.75%; as of August, it was 4.25%. Inflation expectations, however, remained at 3% for the year (after a previous re-estimation on April 16, 2014 from the 2.85% estimate published in January that year). Similarly, the central bank said expectation for the interest rate would slightly increase, from the previous estimate of 4% at year-end to 4.5%. As a consequence of the rising interest rate, the price on 10-year bonds due in 2024 sank by 1.14 centavo to 126.3 centavos per peso at the close of trading on the day of the rate revision. According to data provided by the central bank, this was the steepest one-day drop since November 8, 2013.

On The Horrizon

Despite the country’s notable momentum in the recent past, Colombia is not immune to the turmoil found in global markets. Like most other emerging market currencies, the Colombian peso depreciated by more than 5% against the US dollar over the course of 2013, at a time when the US Federal Reserve is beginning the gradual dismantling of its economic stimulus programme.

While the depreciation of the Colombian peso has indeed favoured local producers and exporters, it has perceptibly reduced the earnings of foreign holders of Colombian domestic bonds. However, the growing interest in Colombian sovereign bonds is also a reflection of the progress made by Colombia and its macroeconomic policy makers, and particularly the prudent management done by the central bank.